As ever, the times remain ‘interesting’.
You will have much to talk about. I will confine myself
to some brief remarks, firstly about the global scene,
and then about the situation in Australia.

From this distance, the US economy appears to be healing.
The ‘headwinds’ from the housing sector
are lessening, corporations are in a strong financial
position and the labour market is improving, albeit
slowly. Much financial repair has been made. The new
sources of abundant energy in the US will also act
as a growth enhancer. The biggest remaining problems
are how to put the US budget onto a sustainable long-run
footing, and how to manage the exit from extraordinary
monetary policy settings.

In Europe, numerous downside risks that were top of
mind a year ago have not, in fact, materialised –
which is no small achievement. Moreover, there are
signs of a modest cyclical upturn in economic activity.
That said, those downside risks still exist and the
recovery has been described by ECB President Draghi
as weak, uneven, fragile and starting from very low
levels.

China, meanwhile, has continued to grow, more or less
in line with the objectives of the Chinese authorities.
This is more moderate than the double-digit rates China
recorded in earlier times. But it is still a robust
performance and China is now a big economy whose performance
matters for the rest of the world. The key question
in China would be whether the ‘shadow-banking’
system, where much of the growth in financial activity
has been occurring, can be adequately controlled and
kept stable.

The ‘emerging market’ economies have experienced
some turbulence. Until May this year, their problem
was inward flows of capital, resulting in part from
‘spillovers’ from the extraordinary measures
taken by the major countries. This put upward pressure
on exchange rates, and made for easier financial conditions,
which was conducive to rising credit and asset values.
It was also a permissive environment for the continuation
of any underlying imbalances or weaknesses. When the
Federal Reserve began to lay out the conditions under
which it would consider scaling back its extraordinary
measures, and the possibility became real that such
a scaling back might begin this year, capital markets
reacted by scaling back their own purchases of assets
in emerging markets. The situation then became much
less permissive. Financial conditions for a number
of countries tightened, exchange rates started to come
under downward pressure, and policymakers were faced
with the need to accelerate the crafting of responses.

That pressure was lessened when the Fed did not, in
the end, begin the ‘taper’ in September.
Since then, stock markets have advanced, long-term
interest rates have edged down and the US dollar has
weakened. The outflows from emerging markets slowed.
Even in the face of the impending deadline for lifting
the US debt ceiling, markets experienced a relatively
limited amount of disruption (though it is very doubtful
that they would have accepted a default event with
the same equanimity). There was a distinctly more relaxed
tone to the discussions in and around the IMF and G20
meetings in Washington in October than there had been
at like meetings earlier in the year.

But it would be a mistake to relax for very long in
the face of this delay. Surely the ‘taper’
will come. We should hope it will, since it will signal
that the US economy is well established on a recovery
track, and it will start to lessen some of the uncomfortable
spillover effects unavoidably associated with the present
set of policies. For some countries, including Australia,
the beginning of a return to something resembling more
normal conditions, in at least one major advanced country,
would lessen some of the difficulties we face in our
own policy choices.

For some other countries, this may see some resumption
of the less welcome pressures seen earlier this year.
The good news is that we have had a dress rehearsal
of what the beginning of tapering will probably look
like, so we have a sense of the pressure points, and
there is now a window within which to address some
of them. It would be wise for policymakers to use that
window.

Turning to the Australian economy, we have seen, over
the past couple of months, evidence of a lift in sentiment
in the business community. A lessening of political
uncertainty has no doubt helped this, though we should
note that this follows an improving trend in measures
of household confidence that began in the second half
of last year. That uptrend had a setback in mid 2013,
but then resumed.

One force helping household and business confidence
has been a positive trend in asset markets. Over the
past year, the stock market, as measured by the ASX
200 accumulation index, has returned about 25 per cent.[1] The median price of a dwelling in Australia has risen
by about 8 per cent over the past 18 months, reversing
a previous decline. Overall, the net worth of Australians
has increased by around 15 per cent, or more than $800
billion, since the end of 2011.

It is not yet clear to what extent, or when, these
more favourable trends in ‘confidence’ will
translate into intentions to spend, invest and employ.
The pace of new dwelling construction is starting to
respond to higher prices in the established property
market, as we need it to. But at this stage, the available
information suggests that broader investment intentions
in the business community remain subdued. It may be
a while yet before we can expect to see conclusive evidence
of a change here.

In the interim, some commentators have taken the view
that the property market dynamics are worrying. My
own view, thus far, has been that some rise in housing prices is part of the normal cyclical
dynamic, that it improves the incentive to build, and
that a price rise reversing an earlier decline probably
isn't something to complain about too quickly.
Moreover, credit growth, at between 4 and 5 per cent
per annum to households, and less than that for business,
does not suggest that rising leverage is so far feeding
the price rise. Hence it has been a little too early
to signal great concern.

There are, however, two caveats. The first is that,
notwithstanding the above comment, credit growth may
pick up somewhat over the period ahead. So this is
an area to which we will, naturally, pay close attention.

Secondly, while overall credit growth remains low at
present, borrowing is increasing quite quickly in some
pockets. Investor participation in housing in Sydney,
in particular, is becoming noticeably stronger. Over
the past year, the rate of finance approvals for this
purpose has increased by 40 per cent.

We have certainly experienced higher rates of growth
of finance than that in the past, and it may be that
we are seeing some catch-up from a delayed initial response
to fundamentals favouring more investment in housing.
Nonetheless, as this activity continues, lenders and
borrowers alike would be well advised to take due care.
It is very important that strong lending standards
remain in place, and that decisions be based on sensible
assumptions about future returns. That's what we
need if we are to experience a long and sustainable
expansion in housing investment that houses our growing
population at acceptable cost, and pays reasonable
returns on the capital deployed. That's the sort
of outcome we want, as part of the more balanced growth
path for the economy we are seeking over the years ahead.

Another part of the balanced growth path would involve
an expansion in some of the trade-exposed sectors that
have been squeezed by the high exchange rate. The foreign
exchange market is perhaps another area in which investors
should take care. While the direction of the exchange rate's response to some recent events
might be understandable, that was from levels that were already unusually high. These levels of
the exchange rate are not supported by Australia's
relative levels of costs and productivity. Moreover,
the terms of trade are likely to fall, not rise, from
here. So it seems quite likely that at some point in
the future the Australian dollar will be materially
lower than it is today.

The high exchange rate has also had a significant impact
on the Reserve Bank's own balance sheet. It led
to a decline in the value of the Bank's foreign
assets and hence a diminution in the Bank's capital,
to a level well below that judged by the Reserve Bank
Board to be prudent. This has been a topic of some interest
of late. Our annual reports have made quite clear
over several years now that, while this rundown in capital
in the face of a very large valuation loss was exactly
what such reserves were designed for, we considered
it prudent to rebuild the capital at the earliest opportunity.
It has been clear that the Bank saw a strong case not
to pay a dividend to the Commonwealth during this period,
preferring instead to retain earnings, so far as possible,
to increase the Bank's capital. That rebuilding
could in fact have taken quite a few years, given the
low level of earnings.

That is the background to the recent decision by the
Treasurer to act to strengthen the Bank's balance
sheet, in accordance with a commitment he made prior
to the election. The effect of this is that instead
of it taking many years to rebuild the capital, it
will occur in the current year. This results in a stronger
balance sheet on average, and makes it likely that
a regular flow of dividends to the Commonwealth can
be resumed at a much earlier date than would otherwise
have been the case.

With those few remarks, I wish you well in your deliberations
at your conference today.

Thank you.

Endnotes

This index, by the way, exceeds the 2007 peak, unlike
the more widely quoted standard share price index.
The difference comes from the fact that the Australian
listed company sector has maintained a dividend yield
of around 4.5 per cent, on average, since 2007.